During the last few years, we have witnessed an immense rise within the crypto industry. With the year 2020 being the ‘stay at home’ year and 2021 having looked much the same, the industry growth is hardly surprising. The last two years, especially, helped popularize the crypto world as a viable economic space, appearing as an attractive source of passive income for many.
Since the crypto world got rediscovered as a fruitful ground for opportunities, open even to small enthusiasts and complete novices to cryptography, many have started wondering: what is a token value and how do tokens get value? How do you know which token to acquire?
Much of the answers to these questions lie in tokenomics – the study of token economics. Tokenomics helps us understand how to valuate different cryptocurrencies and tokens and which ones are worth our time and money.
But what is tokenomics really and how does it work?
The basics: what are crypto tokens and what they are not
Let’s first remind ourselves what a crypto token is. Crypto tokens are digital assets of the cryptocurrency that have a certain value and are used for holding or some other purpose on the blockchain. There is more than one type of token. Tokens can be utility, security, and governance tokens.
Utility tokens are used within a project’s ecosystem. They allow you to carry out an operation specific to the ecosystem. A perfect example of this is our very own STUD token. STUD tokens unlock the full potential of the Studyum platform by allowing greater personalization of the system and many additional features.
Security tokens are the equivalent of stocks in markets. They are proof of ownership of project shares. In addition to the ownership, parties who hold security tokens also share any profit generated by a project.
Governance tokens are tokens used to power decisions as regards project development. Their purpose is to stand as a voting right of a holder, allowing them to support different ways in which the project can grow.
Tokens and coins are not the same, but they share many properties, and many principles that apply to tokens apply to coins as well. This is one of the main reasons why many people use them interchangeably. Both are digital assets created using blockchain technology. However, the important distinction between the two is the stand-alone feature of coins compared to tokens.
Coins are a digital currency and they function much like any regular non-digital currency, like USD or EUR. Like fiat currencies have countries in which they are used, so do crypto coins, except these “countries” are blockchain networks. Bitcoin (BTC) functions on the Bitcoin network, ether (ETH) on the Ethereum network, and ada (ADA) on the Cardano network. Tokens, on the other hand, are built on top of the already existing coin infrastructure. Usually, networks have a technical standard that tokens need to fulfill to operate on top of them, as is the case with ERC-20 and BEP-2 tokens.
How it all comes together
Tokenomics represent the economic aspect of crypto tokens or cryptocurrencies. The term combines two words – token and economics. Fundamentally, it is a study of the factors that impact the supply and demand of tokens. The factors in question can be anything from the quality and distribution to the production of crypto tokens. The list of the factors is constantly expanding, as tokenomics is still a developing discipline in its nascent phase. In essence, any factor that affects the value of a crypto token should be included in the study of token economics.
Understanding how each of the factors changes the value of a token and other important aspects that move the token economy is the key to understanding tokenomics. Here is a brief overview of everything you need to know:
One of the primary components of any token is its supply. When it comes to crypto tokens, we recognize three types of supply: circulating supply, total supply, and max supply.
- The circulating supply of a token is the number of issued tokens or, in other words, the tokens that are currently available to the public. Tokens in circulation are all the currently obtainable tokens in the market.
- Total token supply is the number of tokens that exist in the present moment, excluding any that might have been burned.
- Max supply is the maximum number of tokens that can ever be generated. Note that some tokens and coins do not have a max supply. The prime example of a coin with a max supply is Bitcoin which is capped at 21 million tokens.
How these three are developing in a life of a token will affect token price and performance in the crypto world. Basic rules of supply and demand apply to token economics as well – if the supply exceeds the demand (if there are more tokens than there are people who use them), the value of the token decreases. If, however, token demand is high and exceeds the supply, the value of a token often becomes higher due to token scarcity. In the crypto world, token scarcity can be manufactured through planned reductions in token availability.
The way tokens interact within their economy and their purpose is combined in the token model. Today, most token infrastructure is based on the dual token model. In a dual token model, there is always a token pair in which each token has a distinct purpose.
One dual token model example is when there is an inflationary and deflationary token pair. An inflationary token doesn’t have a max supply and it can be generated as time goes on and the need arises. A deflationary token is already capped, having a fixed amount of tokens that can be produced. The purpose of such a token model is to maintain the stability of the token ecosystem. Often, the inflationary token pair is market-dependent – its price will rise depending on the supply and demand. In such a case, the deflationary token has a fixed price that helps reduce market manipulation.
There are also some tokens that use a dual model in which one token is used for funding and the other is used as a utility token. Usually, in such cases, the token used for funding would be market-driven, while the utility token pair is locked to another currency (either crypto or fiat).
The dual token model also applies in the case of NFTs that have lately been increasing in popularity. We can separate tokens into two categories: fungible and non-fungible tokens (NFTs), with fungible being the ones that hold the same value and are, therefore, interchangeable with one other; non-fungible tokens are tokens with differing values, making each of them unique.
Allocation and distribution of tokens
Tokens are most commonly generated in two ways: first, by being pre-mined and then via a fair launch (an ICO).
Before a token becomes publicly available in an ICO, it can be pre-mined. This is often done to ensure sufficient backing prior to a fair public launch. Premining is the process of issuing a set number of tokens that will be distributed among some exclusive addresses (project developers, team members, early acquirers, etc.) to fuel the initial stages of project development.
ICO or Initial Coin Offering is the issuance of the token by project organizers to raise means for further project development. To do this effectively, they first need to decide on the ICO’s structure. For example, project organizers can choose to structure the ICO with a:
- Static supply and static price
In this case, the organizers set a specific funding goal or limit, which means there is a fixed total token supply and each token sold in the ICO has a pre-set price.
- Static supply and dynamic price
An ICO can have a static supply of tokens and a dynamic funding goal —this means that the amount of funds received in the ICO determines the overall price per token.
- Dynamic supply and static price
Some ICOs have a dynamic token supply and a pre-set price, meaning that the amount of funding received determines how many tokens will be issued.
ICO is a broad subject and there is much more to be said on it. Therefore, we will let the readers do their own research on this topic.
Another way to issue tokens is through an IDO or Initial DEX Offering. Many new projects have opted for this method of public fundraising in recent years for several reasons. IDOs can offer better liquidity and are more open and fair compared to other token distribution methods. As a project dedicated to democratizing learning and making learning opportunities more accessible and learning outcomes more transparent, Studyum has also chosen this method.
Token market capitalization
Market capitalization also known as market cap refers to the entire amount of funds that have been purchased in a crypto project at a given time. It can be calculated by multiplying all the mined tokens with the current token price.
If the max supply of a token is already in circulation, a project can rely on the so-called fully diluted market cap, a theoretical market cap of a token. The value of a token usually rises when the market cap is high and its circulation is low, and this also works in the reverse – the lower the market cap and the higher the circulation, the more likely it is that the token will be devalued.
These basic tokenomics concepts are vital for profit-making for anyone interested in acquiring in crypto or diving into the crypto world. The best way to avoid falling victim to a scam is to do thorough research. This applies not only to cryptography, economics, and blockchain in general but also to promising projects and interesting tokens you might be considering.